Economics 101

There has been a lot of talk about how this summer’s drought might affect food prices. Much of the talk centers on corn, which is far more ubiquitous than many people realize, a component of many processed foods, as well as cereal and chips. The nation’s corn crop has shrunk, and people have to eat, so it makes sense that less supply and more demand will mean higher prices.

The USDA’s latest Crop Production Report said the U.S. corn crop will be 13 percent smaller than the amount harvested in 2011 and the smallest crop since 2006. The soybean crop will be 12 percent less than last year. Recent corn prices hit record levels of nearly $9 a bushel. Wheat and soybeans also hit multiyear highs.

Critics like to blame ethanol for competing for the nation’s corn crop and driving up the cost of food. But food prices are far more sensitive to the cost of energy. And families that find the cost of steaks too high will shift their eating habits to hamburger or beans.

Markets tend to be self-leveling that way. You can’t charge more for a bushel of corn than people are willing to pay. The way that people clamor for government intervention during any perceived crisis, you have to wonder whether modern economics classes devote even a day or two to that topic anymore.

In fact, the higher cost of feed corn is likely to drive down the cost of meat, at least initially.

“Because it’s so much more expensive to keep them and feed them, you may actually get more cattle being brought to slaughter, so beef prices may actually in the very near term have downward pressure,” said banking industry economist Michelle Girard.

But the federal government plans to buy $170 million of meat and poultry to prop up prices hit by the glut of supply as livestock producers rush their herds to slaughter. If you miss out on bargain beef, thank Uncle Sam.

Meanwhile, ethanol producers, who also buy corn, have scaled back production, which will ease demand.

The Federal Reserve Bank of Kansas City, which keeps an eye on global markets, reports that Asian and South American nations have boosted their corn crops in recent years in response to higher U.S. prices, noting, “The best cure for high prices might be high prices.” Corn brokers who can’t get $9 for a bushel of corn in their home nations will be glad to sell it here.

Another thing to keep in mind is that a lot goes into the price of a box of corn flakes, including the cost of ag inputs such as herbicides and fertilizer, manufacturers’ wages and fuel and transportation. Only a few cents ever make it back to the farmer. Commodities like corn and wheat make up roughly 14 percent of the retail cost of food, according to the USDA. The rest of the supermarket price represents processing, packaging, shipping and marketing.

As a result, the Kansas City Fed report estimates this year’s drought could add about 4 percent to retail food prices next year. Since the cost of food makes up about 14 percent of the Consumer Price Index, the drought would contribute just 0.6 percent to overall inflation and knock less than a tenth of a percent off gross domestic product.

Every cent counts in times like these, but that’s hardly a disaster for food consumers or the nation’s economy.